'Pretty soft' earnings raise red flags for 2020

Market analysts have lowered their earnings expectations for Australia's top companies in 2019-20 after a largely unimpressive reporting season left fund managers cautious around the outlook and underlined that technology stocks are still the index's top dogs.

Dividends will again be a source of comfort to investors, with total payouts expected to reach $85 billion in 2019-20, according to MST Marquee analyst Hasan Tevfik, up from a record $84.3 billion in 2018-19.

Sensitivity to interest rates and the eruption of trade tensions emerged as key challenges for Australia's most widely-held companies to grapple with.

"I think that we set the bar reasonably low so it was OK," said Romano Sala Tenna, portfolio manager at Katana Asset Management. "There hasn't been the same level of blow-ups that we have seen in previous years."

A spate of downgrades in the months leading up to the August reporting season saw cement producer Adelaide Brighton, financial group Challenger and fruit and vegetable grower Costa set the tempo for a downbeat month.

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Since the market hit a record high 6845 points on July 30, performance has been less than spectacular in August with the S&P/ASX 200 Index down about 5 per cent making it the worst month since October 2018.

Kate Howitt, portfolio manager at Fidelity International, observed that rising concerns over the potential for a trade breakdown between the US and China likely kept some companies from expressing a more bullish view during reporting season.

"For companies with overseas exposure and currency exposure, management don't want to put guidance out that might be disrupted by trade," she said.

Trade war fears

Mining giant BHP was notably cautious on the outlook for the year ahead as it posted its best profit in five years which nonetheless fell significantly short of consensus forecasts.

Dion Hershan, head of Australian equities at Yarra Capital, acknowledged the eye-popping numbers from miners BHP, Rio Tinto and Fortescue Metals Group but argued that when you remove strong iron ore and gold prices, the rest of the mining sector looked “pretty dreadful”.

The difference, he said, is stark. “When you look forward, costs are going up in the sector, there’s not much volume growth and capital returns appear to have come to an end. It’s almost become one-dimensional around commodity prices.”

Trade turmoil flared up again at the start of the month and sent investors scurrying back to bonds, with yields hitting a record low 0.883 per cent on August 16 for the Australian 10-year government bond.

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Economists believe the Reserve Bank of Australia will lower rates further from the current record low of 1 per cent.

In fact, falling interest rates have provided a "ray of hope" to the companies most exposed to the Australian economy, according to Tribeca lead portfolio manager Jun Bei Liu.

Domestically-focused companies have indicated that they are seeing some improvement in conditions although tangible evidence of improvement is lacking, she said.

Elsewhere, the technology sector released "quite good earnings", Ms Liu said. "Most of them met high expectations and the guidance was in line too." The only exception was Appen which fell 11 per cent per cent on Thursday after steady guidance disappointed investors.

It's clear that "investors are still willing to support the few growth names" in the Australian market, she concluded.

Industrials outperform

AMP Capital's chief economist Shane Oliver observed that financials were the biggest drag on aggregate earnings per share in 2018-19, which declined to 1.4 per cent by the end of the month, from an expectation of 1.9 per cent at the start of August.

EPS for the financial sector fell to -4.4 per cent, he noted, compared to -1.3 per cent at the start of the month. Mining sector earnings also suffered, falling to 12.9 per cent from 15.6 per cent.

Industrials ex financials, on the other hand improved, with earnings moving back from -4.4 per cent to -1.3 per cent.

The 2018-19 reporting season produced the lowest proportion of upside earnings surprises since 2012, Dr Oliver calculated. Only 36 per cent of companies managed to exceed expectations, he noted, lower than the 44 per cent average.

Share price performance on results day told a similar story, he said. "We haven't seen the sharemarket response. It has been about 50:50 as to whether shares outperformed or underperformed the market."

Adding to the impression of a "pretty soft earnings season" only 51 per cent of companies raised dividend payouts, while 27 per cent of companies cut dividends. Those metrics are the worst since Dr Oliver started monitoring dividends in 2012.

While the aggregate dollar value of dividends looks OK, "the fact that more companies are cutting tells me that momentum is slowing and is a sign that companies are less confident. They don’t want to cut dividends in the future," said Dr Oliver.

According to Morgan Stanley's equity strategy team, earnings growth forecasts for fiscal 2020 moved down by 1.7 percentage points to 8 per cent during the August reporting season.

Mr Hershan said it’s important to remember the lesson of overdone earnings expectations. He noted that earnings expectations are running at around 8 per cent for 2020 but is doubtful that growth figure will be achieved.

“I think we are going to see expectations constantly slip and get reset," he warned.

James Thomson is a Chanticleer columnist at The Australian Financial Review based in Melbourne. James was previously the Companies editor and the editor of BRW Magazine. Connect with James on Twitter. Email James at j.thomson@afr.com